China To The Rescue? Unlikely This Time

Economic analysis is a difficult business at the best of times. When analyzing economies, the U.S. is an easy task compared to China. In the U.S., the government data are a pretty good estimation of economic output (despite many doubters) and can be verified by second-tier data like port container volumes, electricity usage, rail carloads, withholding tax receipts, trucking volume, etc. When you look at all of these data it is reasonably easy to get a picture of the present and past economic scene. This is all very helpful in trying to forecast future performance.

At present, for instance, it is clear that for the last year the U.S. has had real GDP growth of about 1.7%. However, China is a completely different challenge. The government data are at times completely unreliable and at others downright deceitful. I remember reading in 2008 that the government statistics showed the economy growing around 7%. However, the electricity companies were saying that electricity usage was down 13% and the rail companies were reporting rail usage down 11%. These types of discrepancies just do not happen in the U.S.. There may be some discussion on the margin, but not on the scale that can be evident in China. This article does not rely on official government data.

As China is becoming important to world growth and is now the world's second-largest economy, how it performs is crucial. In the financial press there are incessant debates on whether China will have a hard or soft landing. This week's economic releases have been weaker than forecast, though not dire. But are they worth anything? In this article I want to look at some general trends that are not short-term predictions, but rather longer-term outlooks.

Before I begin, I wanted to add that I feel growth in the U.S., Japan and Europe is going to be challenged for some years to come. The world presently needs growth from some of the other larger economies to continue on it's present expansionary path.

China Demographics

Population: 1,336,718,015 (July 2011 est.)

Median age: 35.5 years

Total fertility rate: 1.54 children born per woman (2011 est.)

Net migration rate: 0.33 migrant(s)/1,000 population (2011 est.)

Literacy (people age 15 and over who can read and write): 92.2%

Source: All data are from the CIA World Factbook.

The population is therefore reasonably young and well educated, but with a negative birth rate (the rate needs to be above 2.2 to produce a growing population). There has been and will continue to be little immigration to change these demographics. In the longer term, without a change to the one-child policy, China's population will decline.

Economic makeup

With regard to house building, real estate investment in China is 13% of GDP. Unlike the U.S., China does not have an oversupply of housing. In fact, the government has pledged to build 7 million units of public housing in 2012 after an estimated 10 million in 2011. But in order for property investment to add to GDP growth, it has to keep getting larger each year. With real estate prices falling and developers scrounging for credit, China will be hard pressed to outdo 2011's strong showing.

"If they build the same amount [in 2012] that they did last year, which is still a phenomenal rate of construction, then it would take GDP down to 6.6%," said Patrick Chovanec, an economist who teaches at Tsinghua University's School of Economics and Management in Beijing. However, the government pledge is to build only 7 million units. It will require an increase in private house building to keep the growth rate the same. When house prices are falling, this seems an unrealistic assumption.

Consumption makes up 37% of China's GDP. China's consumption is small in comparison to developed economies, but growing. HSBC/Markit suggests that growth in April 2012 was at the fastest pace in six months. China has no social security net, and the population's savings rate continues at a high rate around 25% of household income. This is a good article on the high savings rate. The five-year government plan is for domestic consumption to increase, to replace lost investment and export-led growth. However, the article concludes that the savings rate will remain high, as it is promoted by the government and the banks. It therefore seems unlikely that consumption will fill the gap left by reduced infrastructure investment and exports.

Export-led growth in China is 32% of GDP. Growth of exports of 22.5% for 2011 are projected to slow to 10% in 2012. It is clear that the slowdown in Europe and the U.S. will mean that this forecast will not be revised upward. Export-led growth is set to slow and will be a drag on GDP for 2012.

Conclusion

With 1.3 trillion well-educated citizens, it is clear that the Chinese economy will be one of the powerhouses of growth for the next few decades. However, growth of 9.2%, as experienced in 2011, will only continue if domestic consumption is stimulated. To date, the Chinese authorities have not introduced measures to increase social security benefits or to change policies to reduce the household savings rate. It would appear that they are talking the talk, but not walking the walk. Premier Wen Jiabao suggested recently that growth expectations should be reduced to 7.5%. If the official policy line is for growth of 7.5%, it is likely that "official" growth will come in slightly ahead of this figure. Reality suggests that with housing investment slowing and no policy action to stimulate spending, the real rate will be below 7.5%. If I were to take a stab at the real rate of growth (not the reported rate), I would go for a rate of 6%-6.5% for 2012.

Unfortunately, in my opinion, this is not enough to save the world's stock markets. There will undoubtedly be some further easing of monetary policy in China fairly soon (a required reserve ratio, or RRR, cut to 20% was reported on Saturday), and this will stimulate markets in the short term. The likelihood of fiscal stimulus is slim and without this, the growth rate of the Chinese economy is going to continue to slow. If that assumption is wrong and the new government stimulates the economy, at the end of 2012 the growth rate may remain in the 8%-9% area. Without it, look for continued growth, but at a much slower rate. Describing these types of growth rates as hard or soft landings seems somewhat irrelevant. However, it is clear that China is not going to save the world this time around. I would add China to the roll of economies with slower growth, and I expect the stock markets of the world to continue to soften throughout the remainder of 2012 in the absence of further central bank intervention. Looks like its QE3 and LTRO 3 to the rescue.

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